Contents
Capital Structure
Rationale
Corporate Finance is a specific area of finance dealing with the financial decisions corporations make and the tools as well as analyses used to make these decisions.
The discipline as a whole may be divided among long-term and short-term decisions and techniques with the primary goal being the enhancing of corporate value by ensuring that return on capital exceeds cost of capital, without taking excessive financial risks. Capital investment decisions comprise the long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. Short-term corporate finance decisions are called working capital management and deal with balance of current assets and current liabilities by managing cash, inventories, and short-term borrowing and lending (e.g., the credit terms extended to customers).
Corporate finance is closely related to managerial finance, which is slightly broader in scope, describing the financial techniques available to all forms of business enterprise, corporate or not.
- Capital
investment decisions
- The investment decision
- Management must allocate limited resources between competing opportunities in a process known as capital budgeting.
- The financing decision
Any corporate investment must be financed appropriately. As above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix can impact the valuation. Management must therefore identify the "optimal mix" of financing – the capital structure that results in maximum value. (See Balance sheet, WACC, Fisher separation theorem; but, see also the Modigliani-Miller theorem.)
- Working capital management
- Financial risk management
- Relationship with other areas in finance
- See also
- External links and references
The sources of financing will, generically, comprise some combination of debt and equity. Financing a project through debt results in a liability that must be serviced - and hence there are cash flow implications regardless of the project's success. Equity financing is less risky in the sense of cash flow commitments, but results in a dilution of ownership and earnings. The cost of equity is also typically higher than the cost of debt (see CAPM and WACC), and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk.
Management must also attempt to match the financing mix to the asset being financed as closely as possible, in terms of both timing and cash flows.
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Teaching and Learning Resources
Capital Structure
- Capital Structure
- Capital Structure Analysis
- Capital Structure 1
- Capital Structure 2
- Capital Structure 3
- Capital Structure 4
- Capital Structure 5
Capital
Structure refers to the way
a corporation finances itself through some combination of equity
, equity
options, bonds,
and loans. Optimal capital structure refers to the particular
combination that minimizes the cost of capital while maximizing
the stock price.
Is there an optimal capital structure, one that allows a corporation to get the most bang for its bucks? If so, what is that structure and on what factors does it depend? These are important questions for the discipline of financial economics.
Recommended Texts
Check the availability and buy your books from our Bookshop. |
Financial Statement Analysis: An Integrated Approach Peter
M. Bergevin, Chapter
1: Introduction
to Financial Statements
|
Resources
